Monopolistic Competition: Output, Efficiency, and Markup

Monopolistic Competition: Output, Efficiency, and Markup

Excess Capacity

In monopolistic competition, excess capacity refers to the difference between the quantity at which a firm's average total cost is minimized (the efficient scale) and the quantity the firm actually produces (usually the profit-maximizing quantity).

• Definition: Excess capacity is the amount by which the efficient scale exceeds the quantity that the firm produces.

• Efficient Scale: The quantity of output at which average total cost (ATC) is minimized.

• Profit-Maximizing Quantity: The quantity at which marginal revenue equals marginal cost ($MR = MC$).

• Implication: Firms in monopolistic competition typically do not produce at the efficient scale, resulting in excess capacity.

Example: If a firm's efficient scale is 120 units but it produces only 100 units (its profit-maximizing quantity), the excess capacity is 20 units.

Efficient Scale and Firm Behavior

The efficient scale is the output level where average total cost is at its minimum. Not all firms operate at this scale, especially in monopolistic competition.

• Firms Producing at Efficient Scale: A firm produces at the efficient scale if it operates where ATC is minimized.

• Examples:

  • Dell produces 100 computers a week at which its average total cost is minimized. (This is an example of a firm producing at the efficient scale.)

  • Other firms may maximize profit or revenue at different output levels, not necessarily at the efficient scale.

Additional info: In perfect competition, firms in the long run produce at the efficient scale, but in monopolistic competition, firms typically do not.

Markup

Markup is the amount by which the price of a product exceeds its cost. In monopolistic competition, firms have some market power and can set prices above cost.

• Definition: Markup is the amount by which price exceeds average cost.

• Formula:

$\text{Markup} = \text{Price} - \text{Average Total Cost}$

• Interpretation: Markup measures the firm's pricing power over its costs.

• In Monopolistic Competition: Markup exists because firms face downward-sloping demand curves and can set prices above marginal cost.

Example: If a firm sells a product for $20 and its average total cost is $15, the markup is $5.

Summary Table: Key Terms in Monopolistic Competition

Term	Definition	Example/Application
Excess Capacity	Difference between efficient scale and actual output	Firm's efficient scale is 120 units, but it produces 100 units; excess capacity is 20 units
Efficient Scale	Output where ATC is minimized	Dell produces 100 computers at minimum ATC
Markup	Price minus average total cost	Price = $20, ATC = $15, Markup = $5

Additional info: In monopolistic competition, firms do not achieve productive efficiency (do not produce at minimum ATC) or allocative efficiency (price does not equal marginal cost).